Hindsight biased policy evaluation ∗

In this paper we present a political-agency model in which voters exhibit a cognitive deficiency known as hindsight bias: after the uncertainty about an event is resolved, they consider the realized outcome more foreseeable than it actually was. For their reelection decision, voters evaluate the politician’s ability based on the history of observed actions and outcomes. High ability is defined as an informational advantage over voters as to the welfare maximizing policy. This creates incentives for low-ability politicians to deviate from the optimal policy choice in an attempt to be perceived as possessing superior private information. We show that, because hindsight biased voters are less impressed than rational voters when a risky policy succeeds in spite of public pessimism, the bias acts as a discipline device on low-ability politicians and may thus be welfare enhancing. It also increases political turnover compared to fully rational evaluation. While hindsight bias benefits voters in terms of politicians’ discipline, its effects on selection are ambiguous. These insights may be relevant to other principal-agent relationships without ex ante commitment, e.g., promotion decisions in organizations.